The question boils down to whether a bank has enough data of the right kind to see trends and relationships. “And if you have the data, what is the quality?” Gullette said. He was part of a round-table discussion about the transition to CECL that was webcast by the Global Association of Risk Professionals (GARP) held on January 10, 2018.

CECL requires you to measure credit risk over the lifetime of the portfolio. “Pricing and underwriting are part of that, creating a holistic view from Day 1,” Gullette said.

There are challenges to the modelling of CECL. The standard is not prescriptive. “From a risk management perspective, there must be an agreed-upon model that everybody coalesces around. That will help communicate to the board and investors what the changes are,” he noted. Such a model is capable of automation, and people would understand it better the more they used it.

Gullette cautioned against rushing to fill the need for CECL estimates using an ad hoc model. Ultimately, “such an approach results in much more work,” he said.

The whole process of estimating credit risk “usually takes a few methods,” he said. “Certain methods do not consider all aspects of credit risk, for example, the vintage analysis of charge-offs.”

During the Q&A session, Gullette remarked on the disadvantages faced by smaller financial institutions. “The credit risk evaluation has to be done, whether they have the data or not.” They have more volatility and “a lack of critical mass for operational costs.”

There is talk of zero loss given default (LGD) in some instances. “Take that [zero] with a lot of caution,” he advised. Loans are normally grouped by loan characteristics. “From a practical perspective, LGD is usually above zero. You need to understand and really test the likelihood of zero LGD.”

“You will have questions and you must be able to answer them,” he said. “Whether you have vintage analysis or other models, be prepared for these questions.” He suggested that medium-sized banks not go in with one method and try to fit everything to it. “Look at transition models versus vintage analysis versus other models.”

Adopting the new CECL guidelines will play a big part in strategy planning and decision-making among firms. ª